Not buying into S&P 500 rally

Avi Gilburt is author of
ElliottWaveTrader.net, a live trading room and member forum focusing on
Elliott Wave market analysis. Avi emphasizes a comprehensive reading of charts
and wave counts that is free of personal bias or predisposition. A lawyer and
accountant by training, he is also managing member of Gilburt Financial
Services, LLC, which provides financial markets analysis and consulting. His
Elliott Wave analysis appears frequently on sites such as SeekingAlpha, where he
is a certified contributor, and
TheTechTrader.com with Harry Boxer.

Last weekend, I noted that there was a high likelihood that the bottom was in place for us to see a rally this past week. While we did, in fact, get the expected rally, and the market has moved through our initial targets, we are approaching another potential top of significance and that warrants caution here.

But before I move into the analysis section of this update, I want to take a moment to make a point about how we use Elliott Wave analysis, as some may not understand our process or perspective. Last weekend, I noted that a corrective wave normally targets the .500-.618 retracement region of the prior market move. We use these standard targets to set initial expectations for an upcoming market move. But since the market is non-linear, we have to always be tracking the internal structure to determine if those standard targets are to be maintained, or if we will need to revise the target to a larger Fibonacci extension.

Based upon this perspective, last weekend, I noted the following:

"We do not simply target a single level and place a trade. Rather, we need to see confluence in order to place our trades so as to make them much more high-probability trades. So, again, this will likely be a game-time decision which we will make in our trading room this coming week.

This brings me to a very important point that many seem to overlook when it comes to trading using Elliott Wave analysis. Elliott Wave is more than simply setting a target using Fibonacci extensions and points of confluence. Rather, the structure or form of the pattern is just as important as the target itself.

So, if the structure of the pattern is not clearly within its final stages when we are approaching our initial target, then we must modify our target to the point where the completed structure is projecting, which should coincide with a larger Fibonacci extension.

So, as we were approaching the initial target in the 1569/70ES region this past week, I sent out a Wave Alert that stated that we were set up to head higher than our initial target. This was because the internal wave structure was not matching up with our initial target region, which was the early clue that we were heading to a higher point of confluence. And, as we continued higher, we kept looking for confluence for a potential top.

For those looking for market cues about when to trade on the short side for a top in the market, either you will wait for the pattern to complete into a Fibonacci confluence region and short with a one or two point stop just above that Fibonacci resistance point, or you can wait for a 5 wave pattern to the downside after hitting a topping point of confluence with a completed Elliott Wave structure. After that 5 wave move down, it will likely signal that we have begun a change of trend (a potential c-wave down), and you can then short the 3 wave corrective retracement, with a stop placed just at the prior high.

As far as the market patterns I am now seeing, well, let's just say that you should have heeded my warnings in mid-March when I said that the easy money has been made, and it will only get much more difficult from that time forward. The reason I said that was because the 3rd wave of the 3rd wave had completed, and all we were left with was 4th and 5th waves from that point forth, in order to complete the larger pattern. This is what most people note as "topping patterns." This is also why people say that "topping is a process." In fact, it is the reason that we see a lot of choppiness at tops, especially when we see several 4th wave patterns of varying degrees near tops.

As it stands now, my primary count is that we are still within a larger-degree 4th wave. But, unfortunately, the structure that has developed since the ending diagonal top made in early April has not provided us with the type of clarity we would normally like to possess when trading markets. That is why I suggested that many move to the sidelines after banking money from the mid 1300 region where this rally began.

So, yes, there are times like these where the market pattern is not absolutely clear, and those are the times I suggest that conservative investors stay out of the market indices from a trading standpoint, at least until the pattern does become more clear. But now is only a time for aggressive traders to be involved in the markets, and they must take their cues on a daily basis.

As you can see below, my 60-minute chart is quite a mess. I have three different count possibilities that I am seeing currently, all of which point to a top being made in the markets in the near to intermediate term, if it has not been made already. However, only one of the three is immediately bullish, while the others are rather immediately bearish.

Under all circumstances, the 1568/70ES level seems to be the important pivot point that can decide when new highs will be seen. If we are able to break the support, then my minimum target would be the 1543ES region, with the potential to still target below the 1500ES region. It will all depend on whether a 5 wave or 3 wave structure develops after the break down.

But the issue I am seeing in the chart is that the upside seems limited relative to the downside. So, at this time, I do not intend to play this rally from the long side this upcoming week in any way other than day trades.

For when I do not have a clear pattern to trade, that is when I stay out of the market, even though I may lose an opportunity to the upside at this time. I simply feel the risk is too great. However, if we do not complete the 5 waves into the 1600 region, and do see one more larger drop below 1570ES, then I will be seeking an entry point for a final long trade before the summer, which will likely be at least a 100-point rally before we see a top of greater significance.

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